Ukraine trumps Iraq: The 3 biggest geopolitical worries

NEW YORK (MarketWatch)—Investors on Friday proved that they’ve been a lot more worried about Ukraine and the potential for a deeper conflict between the West and Russia than they are about fresh U.S. military action in Iraq.

Here’s a rundown of the three geopolitical fears for investors right now:

Russian invasion of Ukraine

Stocks turned higher, oil lost ground and traditional havens like gold and Treasurys slipped Friday after Russia’s state news agency ran a story that indicated Moscow is looking for a way to de-escalate tensions over Ukraine. Stocks got a further lift, and havens took more of a beating after a news report indicating Russian military drills near the Ukraine border had ended.

AFP/Getty Images

Russia invaded Georgia in 2008.

The market reaction, which saw the S&P 500
SPX, +1.32%
and the Dow
DJIA, +1.38%
post their biggest one-day gains since March and turn positive on the week, shows that investors were always a lot more concerned about events in Ukraine. Stocks held gains even as the U.S. followed through with airstrikes on positions in northern Iraq. This doesn’t mean Ukraine is off the radar, however.

Tensions have waxed and waned for months. Fears Russia could mount a military incursion into eastern Ukraine to support pro-Russian separatists aren’t likely to disappear. Such an event remains among the most unsettling scenarios facing investors now

An invasion would hit so-called risky assets, including global equities, said Nannette Hechler-Fayd’herbe, head of investment strategy at Credit Suisse. Gold, core sovereign government bonds and commodities in general would likely see strong gains, while emerging Europe, Middle East and Africa stocks and euro-zone equities would take the hardest hit, she said, in a note.

“We are not positioned for this risk case, but our investment strategy and portfolios contain several risk-mitigating elements: a U.S. dollar overweight, neutral gold positions, Canada equity overweight (and energy market overweights in commodities) and a neutral stance on the more defensive U.S. equity market,” Hechler-Fayd’herbe said.

Cutting off Russian gas

An outright Russian invasion of Ukraine isn’t the only fear. Longer term, there’s still the threat that the tit-for-tat sanctions battle between Moscow and the West could see Russia move to use its most potent economic weapon.

Bloomberg

“Given the limited direct trade links from Russia to Europe, we believe this is the main area where Europe could get hit directly,” said Allan von Mehren, chief analyst at Danske Bank in Copenhagen. “It would also increase the negative-sentiment effect significantly.”

The conflict is already putting a damper on sentiment. German factory orders and economic confidence have weakened, and fears are growing that the uncertainty surrounding Ukraine could see Europe effectively talk itself back into recession, said Dan McElwee, executive vice president at Ventura Wealth Management, in a phone interview. Indeed, European Central Bank President Mario Draghi on Thursday said the geopolitical turmoil posed an added threat to a recovery that remains weak, fragile and uneven.

McElwee said investors might want to rethink allocations built previously on the idea that Europe ‘s economic recovery was due to gain momentum. “People were betting big on your big, multinational industrial companies, thinking they were going to be large beneficiaries from a European recovery. What happens if that doesn’t take hold?”

The Middle East

“Escalating and spreading violence in Gaza and the broader Middle East could increase oil prices or raise terrorism fears,” said Markus Schomer, chief economist at Pinebridge Investments.

Reuters

Israeli soldiers take position along a fence in the southern town of Sderot during infiltration by Palestinian militants last month.

For now, however, concerns about the situation in Iraq, much less any spillover consequences from fighting between Israel and Hamas, have had little lasting effect on oil prices. September Brent crude futures
LCOU4, -0.69%
the global benchmark, were down 51 cents on Friday as the U.S. mounted airstrikes, leaving them on track for a weekly rise of less than 0.1%. September WTI crude
CLU4, +0.00%
on Nymex, the U.S. benchmark, was up 25 cents at $97.58, on track for a 0.3% weekly loss.

Oil prices temporarily spiked in June as Sunni-led insurgents swept across northern Iraq but soon turned back on expectations that Iraq’s southern oil fields and export facilities would remain insulated from the violence. Brent crude is down 6.7% since the beginning of July, while Nymex futures are off 7.4% over the same stretch on a nearby-futures basis.

There are always geopolitical scenarios that could potentially rattle investor sentiment. But outside of Ukraine and the Middle East, it’s difficult to identify issues that seem capable of stirring fears in the near term. And even the seemingly scary threats posed by the top geopolitical hot spots, for now, seem to be more likely to provide footholds on the stock market’s so-called wall of worry than to fuel a lasting downside correction.

“So many investors have sat this whole bull market out,” McElwee said, “that they’re looking for any type of pullback as an opportunity to get in.”

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